How to Trade a “Back in Whack” Market
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In other words, don’t base your decisions today on hopes for the future.
We’ve all heard this advice… even if we’re not always the best at heeding it.
And that feature of the human condition might explain all the optimistic chicken-counting after the Fed’s last press conference on Dec. 13.
With the prospect of the first rate cuts since 2020 on the table, greed got the better of investors. Expectations got “out of whack.” Stocks soared into year-end. Even we, here in TradeSmith Daily, made a point to look at how stocks perform post rate-cuts… and suggested some sectors for your shopping list… with stars in our eyes.
Now, halfway through the first month of 2024, expectations are getting back “in whack”… and stocks are sputtering.
This isn’t a “gut feel” thing. We can see it in the data.
So today, we’ll go over traders’ Fed rate-cut expectations… the last week’s price action… check in on the Fed’s own estimations of the first rate cuts… and share our thoughts on what to do if this dip keeps on dipping.
❖ Out-of-whack rate-cut hopes are shrinking before our eyes…
The CME Group’s FedWatch tool is an incredibly informative look at investor expectations.With it, we can see where traders believe the Fed’s key rate will be, based on futures-pricing data.
As it turns out, the last month has brought on a serious recounting of rate-cut eggs. On Dec. 15, the FedWatch tool suggested a 10% chance of a rate cut coming on Jan. 31, the next Fed meeting on the docket. Today, that probability stands at 2.6%.
Further time frames are even more informative. Just one week ago — notably the day before the most recent Consumer Price Index report — traders were pricing in a 65% chance of a 0.25% rate cut by March 28. Now, that’s shrunk to 57.6%.
Traders may want rate cuts sooner. But a hotter-than-expected inflation report and a stronger-than-expected consumer spending report is tempering expectations — not to mention taking the wind out of stock bulls’ sails.
❖ On Wednesday, stocks posted their worst day in the last month…
The S&P 500 fell almost 1%, while the tech-heavy Nasdaq fell almost 1.5% at the lows.Treasury yields also jumped higher, with the 10-year yield jumping back above 4%.
To borrow another tried-and-true phrase, we’re not out of the woods yet. While stocks struggle through January, Treasuries across the duration spectrum are proving to be stubborn competition. That’ll remain the case for as long as the Fed’s key rate remains high.
And that could be the case for quite some time. Federal Reserve Bank of Atlanta President Raphael Bostic said yesterday that he doesn’t expect the Fed to cut rates until the third quarter, or until inflation is convincingly back at the Fed’s 2% target.
The hesitation on the Fed’s part is a repeat of the 1970s, when inflation came in waves and premature interest rate cuts failed to put a lid on it. It wasn’t until Paul Volcker’s Fed raised the federal funds rate to 20% in 1980 that inflation finally got squashed.
Once again, investors are overestimating how accommodative the Fed is going to be with interest rates. There’s a strong possibility that Bostic is right and we won’t see any rate cuts until summer.
But here’s the thing, though… this tracks with a lot of what we’ve been sharing here in TradeSmith Daily.
History shows that election-year volatility tends to strike in the first quarter to first half, with a huge recovery in the back half of the year.
If the first rate cuts are going to light a fire under stocks, and we’re not likely to see those first cuts for some months… then that lends more ammo to the argument of a weaker few months ahead.
❖ TradeSmith options pro Mike Burnick laid out his take for subscribers earlier this week…
Here’s Mike with his thoughts on the dance between markets and the Fed…[The] CPI has fallen steadily over the past 12 months now. It’s hovering at just 3.4%, down from a peak above 9%. And yet the benchmark Fed policy interest rate remains at the highest level in over a decade, at 5.25% to 5.5%.
That means monetary policy is clearly restrictive… and the longer it stays this way, the more vulnerable our economy is to a slowdown.
Something’s got to give. Investors are betting it’ll be the Fed that gives in and starts lowering rates in the first half of this year. But if the Fed hesitates to do so, the stock market rally could be lost.
That means monetary policy is clearly restrictive… and the longer it stays this way, the more vulnerable our economy is to a slowdown.
Something’s got to give. Investors are betting it’ll be the Fed that gives in and starts lowering rates in the first half of this year. But if the Fed hesitates to do so, the stock market rally could be lost.
I’d add on that the Atlanta Fed expects GDP for the fourth quarter of 2023 to come in at 2.4% — a drop from the near-5% shocker from third quarter, but still a steady number that could discourage a sooner rate cut.
Mike watches the markets and economy closely, as any good trader does. But I’ll note that his trading strategy is pretty well insulated from what’s happening at the 1,000-foot view.
Mike’s claim to TradeSmith fame is generating consistent income by selling put options. That knowledge makes him the perfect “copilot” for readers using TradeSmith’s advanced put-selling algorithm, which shares great income plays with minimal risk every day. (I’ll share a more in-depth look on this strategy in an essay coming your way this weekend.)
Over the last 10 months, the Constant Cash Flow algorithm has helped readers claim instant, upfront cash injections to their portfolios with outstanding success.
Since those trades started going out on March 15, 2023, the Constant Cash Flow strategy has generated a 99% win rate across hundreds of trades… generating over $10,000 in income.
If it sounds impressive, that’s because it is. I’ve seen a lot of option-selling strategies out there in the wild, but never one that can boast such an ironclad track record and consistent returns. (That’s what happens when you have TradeSmith’s world-class analytics and datasets backing you up.)
As a TradeSmith Platinum subscriber, you already have unlimited access to Constant Cash Flow and everything that comes with it.
My advice to you is to start following the daily lunchtime emails with new recommendations in your inbox (if you aren’t already).
Then, check out the Constant Cash Flow model portfolio to find the latest recommendations. And access the rest of what we have to offer in TradeSmith Finance right here.
To your health and wealth,
Michael Salvatore
Editor, TradeSmith Daily